What is Simple Interest?

Suppose Ramesh borrowed 1000 rupees from Bank. This is called Principle (P) amount.

Now while lending money Bank asked him to pay extra 5% or Rs 50/1000. Here 5% is called Rate of Interest (R).

Ramesh has promised to pay the money back after two years with interest, so 2 years is Time period (T).

As Ramesh has to pay Rs. 50/1000 per year, so after two years he has to pay Rs. 100 extra. This extra money is called Simple Interest (SI).

After two years Ramesh will pay (1000+100) = Rs. 1100 to Bank. Money paid back is called Amount.

Important Formulae on Simple Interest:

SI = (P * R * T) / 100

P = (SI * 100) / (R * T)

R = (SI * 100) / (P * T)

T = (SI * 100) / (P * R)

Amount = Principle + SI.

What is Compound Interest?

Taking same case we discussed above Ramesh borrowed Rs. 1000 from a Bank at 5% Rate of Interest for Time Period of 2 years, but bank has asked him to pay compound interest annually. So in this case amount will be calculated annually.

After one year amount will be P + SI = 1000 + 50 = 1050.
So for second year Principle will be 1050.
SI for second year = (1050 * 5 * 1) / 100 = 52.50
So amount after 2nd year will be P + SI = 1050 + 52.50 = 1102.50.
Hence Compound Interest (CI) he paid = 1102.50 - 1000 = 102.50.

Important Formulae on Compound Interest:

I. When CI is calculated Annually:

Amount = P * (1+R/100)T

CI = Amount - Principle

II. When CI is calculated Half - yearly:

Amount = P * {1+(R/2)/100}2T

CI = Amount - Principle

III. When CI is calculated Yearly but time is given in fraction say 2 (1/2) years ( 2 and half year).

Amount = P * (1+R/100)2 * {1 + ((1/2) * R)/100}

IV. When Rates of Interest are different for different years, say R1,%, R2%, R3% for 1st, 2nd and 3rd year.

Amount = P * (1 + R1/100) * (1 + R2/100) * (1 + R3/100).

V. Concept of Equal Installment when interest is compounded annually:

Let us suppose P money is borrowed for 2 years at R rate of interest and we have to return the money in 2 equal installments annually. Then the installments will be?

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